What is a good response to? Fair value hedges are used to mitigate exposure to fluctuations in the fair value of an asset or liability. In order to be eligible, the change in the fair value of the asset or liability must have the potential to affect the earnings of a company. This type of hedge can be used with the purchase of raw materials. The value of raw materials, the current market price can change; therefore, this type of hedge can offset any anticipated changes in the value of the raw materials. Cash flow hedges are used to minimize the risk of future cash flow fluctuations from an asset that is already held, liabilities, or future transactions. These hedges are eligible if changes in cash flow can affect the income statement. This type of hedge can be used with future purchases for a company. For example, if a company is expected to purchase materials at a certain price, this type of hedge will ensure that the purchase price doesn’t change due to the contract in place. Net investment hedges are used to minimize the chances of fluctuating reported earnings that come from the future sale of a net investment from a foreign operation. This type of hedge can be with a company engaged with a foreign company. Currency exchange can be affected by depreciation of different currencies; therefore, this type of hedge can help to offset any potential losses from exchange rates.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter13: Capital Budgeting: Estimating Cash Flows And Analyzing Risk

Section: Chapter Questions

Problem 11Q

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What is a good response to?

Fair value hedges are used to mitigate exposure to fluctuations in the fair value of an asset or liability. In order to be eligible, the change in the fair value of the asset or liability must have the potential to affect the earnings of a company. This type of hedge can be used with the purchase of raw materials. The value of raw materials, the current market price can change; therefore, this type of hedge can offset any anticipated changes in the value of the raw materials.

Cash flow hedges are used to minimize the risk of future cash flow fluctuations from an asset that is already held, liabilities, or future transactions. These hedges are eligible if changes in cash flow can affect the income statement. This type of hedge can be used with future purchases for a company. For example, if a company is expected to purchase materials at a certain price, this type of hedge will ensure that the purchase price doesn’t change due to the contract in place.

Net investment hedges are used to minimize the chances of fluctuating reported earnings that come from the future sale of a net investment from a foreign operation. This type of hedge can be with a company engaged with a foreign company. Currency exchange can be affected by depreciation of different currencies; therefore, this type of hedge can help to offset any potential losses from exchange rates.

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